Six Costly IRA Missteps to Avoid

It’s tax filing season—which makes it a good time to check that you haven’t made mistakes with your individual retirement account. U.S. taxpayers now hold $5.2 trillion in these accounts, but they contain traps for the unwary that can be costly. Here, according to the experts at Charles Schwab, are a half-dozen mistakes to avoid—along with the penalties for making them.

1. Putting in too much. If you contribute more than the law allows, the penalty is 6% of the excess amount for each year you fail to correct the problem. For more information about types of IRAs and contribution limits, see the IRS website. Schwab also has a page devoted to the accounts; click here.

2.Making prohibited investments. IRA owners aren’t allowed to invest directly in collectibles, including artwork, antiques, gems, stamps and coins. IRAs can hold some precious metals, including certain gold, silver and platinum U.S.-minted coins, but the owner can’t keep them at home or in a safe-deposit box. An IRA custodian must hold them instead. If an IRA owner invests account assets in collectibles, the amount invested will be considered withdrawn in the year the investment is made. It will be subject to income tax and, in many cases, a 10% early withdrawal penalty, if the investment was made before the owner turned 59½.

3. Engaging in prohibited transactions. These include borrowing money from the IRA, selling property to it, receiving unreasonable compensation for managing it, using it as security for a loan and using IRA funds to buy property for personal use (such as a vacation home). Engaging in such transactions can subject the entire account to tax.

4.Making a restricted rollover. IRA owners can make unlimited “trustee to trustee” transfers of their accounts in any given year. But if they take receipt of the money in the account, it must be transferred into another IRA within 60 days. Miss this deadline and the account will likely be fully taxable. Plus, account owners younger than 59½ will often owe a 10% penalty. Other restrictions may also apply.

6. Missing an RMD. IRA owners 70½ and older, plus people (except spouses) with inherited accounts, must take annual required minimum distributions from the account. The penalty for failing to take a required RMD is a whopper—a 50% excise tax on the required payout in addition to ordinary income tax.